On June 11, 2018, staff of the Canadian Security Administrators (the “CSA”) published CSA Staff Notice 46-308 – Securities Law Implications for Offerings of Tokens (the “2018 CSA Notice”), which provides additional guidance on token offerings, including those characterized in the industry as “utility tokens”. The 2018 CSA Notice: (i) provides examples of situations in which an offering of tokens may be subject to securities law, and (ii) addresses multiple step token offerings.
The CSA has previously confirmed that securities law may apply to cryptocurrencies, depending on the circumstances of the token offering. On August 24, 2017, staff of the CSA released CSA Staff Notice 46-307 – Cryptocurrency Offerings (the “2017 CSA Notice”). See here for our detailed commentary on the 2017 CSA Notice.
General Guidance on the Application of Securities Law to Token Offerings
The 2018 CSA Notice reminds stakeholders that the established tests of determining the existence of a “security” will apply when determining if a token is a “security”. The CSA stated an offering of a token may involve the offering of securities where, among other things, the offering involves the distribution of an “investment contract”. In accordance with case law, to determine the existence of an “investment contract”, one must consider whether the offering involves (1) an investment of money (2) in a common enterprise (3) with an expectation of profit (4) to come significantly from the efforts of others.
The CSA noted that both the technical aspects of the token and the economic realities of the offering as a whole will be considered when determining whether a token is a security, with a focus on substance over form.
Examples of Situations in which a Token may be an Investment Contract
The 2018 CSA Notice was prompted in part by the regulators’ experience in responding to token offerings proposed to them by individuals and businesses. Many of the proposed token offerings involved “utility tokens”. Utility tokens are described in the industry as tokens with one or more specific functions. For example, the token might allow a holder to purchase services or assets based on blockchain technology (similar to having poker chips at a casino). Proponents of classifying tokens as “utility tokens” argue that utility tokens are not securities. The CSA found that most offerings purporting to be utility tokens involved the distribution of a security and emphasized that simply because a token has some utility does not mean that it will not be a security.
The 2018 CSA Notice provides helpful examples of situations in which tokens/token offerings might meet certain “investment contract” criteria depending on the circumstances. The examples provided are not intended to be an exhaustive or determinative list. Some of the key themes underlying the examples provided are:
- Even though the proposed function of a token may be utility, there may be some purchasers who purchase tokens with the intention of selling them on a cryptoasset trading platform or in a secondary market. This fact may indicate an expectation of profit under the “investment contract” criteria.
- In instances where the purchaser is not gaining immediate utility of a token (i.e., where the token is purchased, but there is a delay in its delivery or the software that uses the token is not functional) there may be a common enterprise under the “investment contract” criteria because of the reliance on management to deliver the token and/or a workable utility system. In other instances, purchasers may rely on management to increase the value of a token (i.e., where tokens are offered to raise capital that will be used to perform key functions that will support the value of the token and the underlying business), indicating a common enterprise under the “investment contract” criteria.
- While the interpretation of “investment contracts” is broad, tokens that have a pre-determined fixed value (if any) that will not change or are not fungible or interchangeable, have unique characteristics and are intended to be collectible may not meet the “investment contract” criteria.
Offerings of Tokens Structured in Multiple Steps
The CSA recognized that token offerings structured in multiple steps may be subject to securities law. CSA staff provided the following structure as an example:
Step One: A purchaser contributes money in exchange for the right to receive tokens at a future date. No tokens are delivered, but an agreement is entered into, such as a “simple agreement for future tokens” or a “SAFT”.
Step Two: The tokens are delivered to the purchaser. At this stage, the issuer has typically represented to the purchaser that the software or application is built or the goods/services are available, so the tokens are functional.
In response to the use of multiple step transactions, the CSA indicated the following:
- The token distribution in the first step is generally a distribution of a security, specifically the right to a future token. If there is a distribution of a security at any stage of the offering, it will be subject to the prospectus requirement and issuers may consider relying on a prospectus exemption.
- An issuer in the business of trading in securities will need to comply with the dealer registration requirement. The term “trade” is defined broadly and includes acts, advertisements, solicitations, conduct or negotiation directly or indirectly in the furtherance of a trade.
- The CSA has concerns where offerings are structured in a manner that attempts to avoid securities legislation. As previously noted, the CSA and will assess the economic realities of the offering as a whole, with a focus on substance over form.